Currency woes to shake US markets?

By , Staff writer of The Christian Science Monitor

Wall Street has something new to worry about: a weakening United States dollar.

"A weaker dollar will have a negative effect on the stock market," says Neil Williams, an analyst in London for Goldman Sachs, a major investment banking firm. He suspects the weaker dollar explains in part the decline in stock prices in New York.

The argument Mr. Williams and some other analysts make goes like this:

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For years, the US has financed its growing trade deficit and a domestic shortfall in savings by borrowing abroad.

Foreigners were glad to oblige. The US economy and stock market were booming. They offered fine profits. Foreign companies invested heavily in US businesses.

Contrariwise, Japan's economy and market were in a dragged-out slump. Europe's economy was moving at a slow pace. Southeast Asia was in crisis.

But the scene is changing.

Japan's economy is picking up. Tokyo stock prices are rising rapidly. Europe is showing more vigor. Asia is recovering. And the US economy may be slowing.

Dollar investments are becoming "less attractive," notes Adam Posen, an economist with the Institute for International Economics in Washington.

Foreign investors had heavily overweighted their portfolios in American stocks and bonds. Now some are shifting funds out of the US to a brighter Japan, Europe, or elsewhere abroad.

This outflow will continue to weaken the dollar. Thus imports will cost more, adding to US inflation. Moreover, the weaker dollar will make it easier for US companies to export and compete with imports. That will boost US economic activity at a time when the Federal Reserve wants to see a slowdown.

"It's raising concerns at the Fed," figures Sal Guatieri, an economist in Toronto with the Bank of Montreal.

So, when Fed policymakers next meet Aug. 24, they will be tempted to raise interest rates in an antinflationary move. Or the outflow of funds will push up rates regardless as investment money gets scarcer in the US.

"There is a scissors movement here," says J. Paul Horne, an economist in London for Salomon Smith Barney. Investment flows will be unfavorable for the US economy and stock markets; favorable for Europe's economy and stock markets.

When the euro was created Jan. 1, it was worth $1.17. Contrary to forecasts, its value soon fell, reaching $1.01 July 12.

"Euroskeptics," those in Britain opposed to their nation joining the 11-nation European Monetary Union with its single euro currency, were preparing for "parity parties" to celebrate the day when the dollar and the euro were equal in value.

It didn't happen. The euro is now back up to about $1.08.

In the case of Japan, for the first half of this year it took about 120 to 125 yen to buy $1. But since early July, the yen too has appreciated. Early last week it took only 114 yen to buy $1.

Japanese officials don't like that trend. A stronger yen makes it tougher for Japanese companies to export. They are afraid this might abort the tentative recovery.

Japan bought some $30 billion of dollars on foreign exchange markets in the past two months to weaken the yen.

Also, Japan's finance minister, Kiichi Miyazawa, chatted with the new US treasury secretary, Lawrence Summers, about the situation. Mr. Miyazawa told parliament. last week they agreed that "sudden changes in foreign exchange rates are undesirable."

Whatever, the yen fell under 114 as traders became convinced that the US Treasury would not act to bolster the dollar.

If the economic fundamentals do not support a particular exchange rate, "government intervention will ultimately prove unsuccessful," warns Mr. Williams.

Mr. Summers repeats the view of his predecessor, Robert Rubin, that "a strong dollar is very much in the interest of the US." He also shares Mr. Rubin's opinion that intervention should be avoided.

But what happens if investors panic and the dollar plunges fast?

Then the US and other nations "will do what is needed to stop it," figures Harvard University economist Richard Cooper.

Economic ideology will tumble.

(c) Copyright 1999. The Christian Science Publishing Society

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